By Jennifer Ryan
Aug. 7 (Bloomberg) -- Bank of England Governor Mervyn King is betting that he can keep pumping money into the economy without an outbreak of inflation once growth returns.
The central bank yesterday added 50 billion pounds ($84 billion) to its asset purchase plan, taking it beyond the previous limit granted by the Treasury. Economists say King’s move risks stoking excessive inflation as the bank pumps a total of 175 billion pounds into the economy, equivalent to 12 percent of gross domestic product.
“It’s a gamble,” said Peter Dixon, a London-based economist at Commerzbank AG, Germany’s second-biggest bank. “The more we throw at this problem, the bigger the potential exit strategy risks will be.”
The Bank of England said yesterday that Britain’s recession has been deeper than officials anticipated. Deputy Governor Charles Bean warned in July that the bank risks stoking inflation if it waits too long before withdrawing stimulus and King has said that the timing of an exit strategy will still be a “tricky judgment.”
The pound has dropped 1.4 percent against the dollar since yesterday’s decision. The U.K. currency traded at $1.6743 as of 10:34 a.m. in London. The 10-year gilt yield has fallen 15 basis points to 3.678 percent. Eight of 12 primary dealers that bid at government debt auctions had predicted the central bank would announce a pause yesterday.
ECB Contrast
The scale of King’s commitment contrasts with the European Central Bank, which has so far only bought 5.1 billion euros ($7.3 billion) in covered bonds and is focusing its emergency measures on pumping money into the economy through refinancing operations.
“We are not in a situation where the instruments we have utilized are complicated and would hamper an exit,” ECB President Jean-Claude Trichet said in an interview on Bloomberg Television in Frankfurt yesterday. “We chose instruments that are easy to exit.”
Inflation in the U.K. will be the fastest in the Group of Seven nations next year, which may force the Bank of England to raise interest rates before other central banks, the Paris-based Organization for Economic Cooperation and Development predicts.
Producer prices in Britain unexpectedly rose 0.3 percent last month after manufacturing picked up the previous month, data from the Office for National Statistics showed today.
The bank said yesterday that the pound’s weakness has put “upward pressure” on consumer prices. The U.K. currency has fallen 9.6 percent from a year ago against a basket of currencies of Britain’s major trading partners.
Slowing Inflation
U.K. central bank officials are for now emphasizing that deflation remains the economy’s bigger threat. They predicted in May that inflation may slow below 1 percent in the fourth quarter and will release new forecasts on Aug. 12. The projections may show whether the bank has become more concerned that inflation will be even slower.
The inflation rate fell to 1.8 percent in June, dropping below the bank’s 2 percent target for the first time since September 2007. The government’s former inflation measure, the retail price index excluding mortgage interest payments, has already dropped to 1 percent.
Bean told the BBC last month that “we’re not going to get inflation without having had a recovery first,” and that “we’ll get inflation if we pump too much extra money into the economy and then we don’t withdraw it fast enough.”
Outstanding Debt
The bank’s move has now left it committed to buying up as much as 22 percent of the total amount of outstanding U.K. government bonds.
“It’s an enormous amount now,” said Neville Hill, an economist at Credit Suisse Group in London and a former U.K. Treasury official. “They’re over-clubbing it. This means they think the consequences of downside risks materializing are just so severe that it’s better to play along to the upside risks.”
King’s move may nevertheless help Prime Minister Gordon Brown, who is trying to ensure the economy revives before national elections which he must call by June next year.
“If it helps support a recovery, it’s helpful for the government,” said Jeavon Lolay, an economist at Lloyds Banking Group Plc in London.
Some economists say that the U.K. recession is deep enough to curb inflation. The slump has shrunk the economy by 5.7 percent, compared with a total 6 percent drop in the contraction that ended in 1981. Royal Bank of Scotland Group Plc today reported a first-half loss as it set aside 7.52 billion pounds to cover bad loans and declining asset values.
“I don’t think it’s a gamble,” said Andrew Milligan, head of global strategy at Standard Life Investments Ltd. in Edinburgh and a former U.K. Treasury official. “I see little harm in expanding quantitative easing at this time. We’ve stopped a multi-year recession and have generated signs of a recovery. The damage is going to take time to repair, and unconventional policies are warranted.”
To contact the reporter on this story: Jennifer Ryan in London at Jryan13@bloomberg.net
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